The New Debt Threat

The sub-prime crisis began on August 9, 2007 when BNP Paribas had to halt the redemption of funds as a result of a complete evaporation of liquidity in the U.S. subprime mortgages in which its funds were invested. Countrywide Financial and numerous other lenders could no longer obtain financing starting in 2007. Over the next two years, housing values came racing down, and stock prices followed their precipitous descent.

Ten years later, people throughout the economy are once again worried about myriad potential threats to our economic well-being arising from excessive debt. In fact, based on “debt clock data,” total U. S. debt outstanding at all levels of the economy stands at about $67.5 trillion. This includes Student Loans, Auto Loans, Credit Cards, Mortgages, Corporate Debt, and Government Debt at the Federal, State and Local Levels. The interest rate borrowers pay, on average, is somewhere around 3.7%, and interest payments total $2.5 trillion.

Worldwide, debt is approaching $270 trillion dollars, the highest on record. And this time, North America does not appear to be in the worst shape. Debt levels in China and smaller emerging economies are raising the greatest concern.

So, is another financial crisis brewing? As debt levels relative to GDP have risen after the last crisis, the Bank of International Settlement (or "BIS") has been regularly warning that a new financial crisis is “looming.”

A big part of the concern was caused initially by the financial crisis itself, which crushed GDP almost everywhere. And, since GDP functions as the denominator in the debt-to-GDP ratio, a decline in GDP automatically pushes the ratio higher.

But, the BIS argues that the main reason the debt-to-GDP ratio is still rising even after the recovery of global GDP is “aggressive lending,” driven by interest rates that have been kept too low. However, interest rates are so low mostly because of deflation. As the BIS admits, technology and globalization are strong deflationary forces, that have discouraged central banks from raising rates.

The result is that the Fed and most other central banks have kept rates very low for a very long time, which has inflated the debt-to-GDP ratios in various countries.

However, those aggregate numbers don’t tell us much about the likelihood of a potential financial crisis...